An introduction to the German estate tax and the treaties with the US, France, Greece, Switzerland and Denmark

Introduction and Double Taxation Treaties

This summary is based upon the version of the Inheritance, Estate and Donation Tax Act (ErbStG) in force in 2014. It does not take into account the case pending in the German Federal Constitutional Court that is expected to be decided by the end of 2014 (Record Number: 1 BvL 21 /2012) and future legislative responses thereto.

The core of this matter is that the legislator gives heirs of entrepreneurial legal entities certain advantages over heirs of private wealth by way of various allowances; the issue for the Federal Constitutional Court is whether this violates the constitutional guarantee of equality before the law enshrined in Art. 3 GG. The effect of this is that all German estate and gift tax bills will have to be provisional by operation of law until this final judicial decision has been handed down. This means that the doctrine of res judicata does not apply (§ 165 Para 1 S.2 No. 2. AO, General Tax Act). If a local fiscal authority omits to insert the language necessary to render an individual tax bill provisional, the taxpayer only needs to object in writing within a four week deadline in order to protect possible future rights (§ 355 and § 357 AO).

As of 2014 the only English-speaking country Germany has a double taxation treaty in force with in respect to estate and gift taxes is the United States of America (USA). The very few non-English speaking countries are Denmark, Greece, Sweden, France and Switzerland. Treaties with Finland and Italy are subject to ongoing negotiations. Where these treaties are in force, they regulate which country has the right to tax the whole or part of the estate. The outcome mostly depends upon the domicile and the citizenship of the deceased, and sometimes of the beneficiary. It also depends upon the place where the asset is located and the type of asset involved (e.g. chattel or real estate). However, if no such treaty is in force, it is sometimes, but certainly not always, possible to set off similar estate and inheritance taxes paid in the foreign countries against German inheritance taxes (Art.21 ErbStG).

The German Inheritance and Donation Tax Act is a federal law. This is true even though the final recipients of these taxes are the 16 German states, none of which has its own estate tax regime. However, depending upon the type of assets comprising the estate, other types of taxes might become relevant, for example, the last income tax declaration of the deceased if he had to file one here during his lifetime. Similarly, if a piece of real estate is inherited, municipal ordinances governing access to public services such as the street adjoining the piece of land might become relevant.

The Federal Gift and Estate Tax Act deals with inheritance tax and not estate tax. This means that it is the individual share each heir receives that is taxed and not the overall gross value of the estate. Likewise, the individual heir/donee and not the estate as such is the debtor of the tax (§ 20 ErbStG). The value of the share each heir receives is calculated from the value of the assets comprising this share at the time of death respectively at the time when the gift was made. The calculation of the tax in an individual case also depends upon the value of the share the heir respectively the donee receives, and the closeness of the family relationship between the deceased and the heir respectively between donor and donee.

In the absence of a governing treaty two terms are essential to determine this in international cases. These are the terms of restricted personal tax liability and unrestricted personal tax liability for the purposes of inheritance and gift taxes.

When does German inheritance tax law apply?

§ 2 Para 1 No. 1. ErbStG provides that if either the deceased/donor or the heir/donee are German residents they become subject to unrestricted estate and gift tax liability here. However, the definition of residency here makes this concept rather broad. A person is deemed to be a resident if he or she has a domicile here or a habitual place of physical presence – (generally this means for at least six months)-. German citizens that have totally left the country for a period of less than five years are also still deemed to be residents. In all these cases substantive German estate tax law applies regardless of the type of assets involved and regardless of the place where the asset is located. In all other cases the concept of restricted personal tax liability limits the part of the estate the receipt of which in whole or in part could trigger tax liability here to assets located in Germany (§ 2 Para 2 ErbStG and § 121 of the Valuation Act - Bewertungsgesetz).

The five-year period mentioned above (§ 2 Para 1 Letter b ErbStG) during which German citizens are still deemed to be German residents even after emigrating to a foreign country can even be extended to ten years if certain additional requirements are met. Broadly speaking, these can be summarized as moving away to tax haven jurisdiction with the intent to save German taxes (§ 2 and § 4 of the Foreign Tax Act - Aussensteuergesetz).

Because the German tax is a true inheritance tax, exemption amounts as well as the tax itself depend upon the family relationship between the beneficiary and the deceased or donor. The code formulates so-called tax classes (§ 15 ErbStG). Class 1 includes spouses and members of a registered life-time partnership of persons of the same sex, children, stepchildren and their children, parents and grandparents (for transfers upon death). Class 2 includes parents and grandparents (for life-time transfers), siblings, nieces and nephews, parents and children in law, divorced spouses and former members of dissolved lifetime partnerships. Class 3 includes anybody else.

In the case of restricted tax liability, to summarize and simplify this again, this means that neither the deceased/donor nor the beneficiary has any link with Germany other than a few assets which happen to be located here; the only amount exempted from this tax is € 2,000.-. In the case of unrestricted tax liability the exempted amount according to § 16 ErbStG for spouses and life-time partners of the same sex is EUR 500,000; for children and the children of predeceased children it is EUR 400,000, and EUR 200,000 for other grandchildren. For any other member of tax class 1 the allowance is EUR 100,000, while for members of tax classes two and three the exemption amount is only EUR 20,000. Children below the age of 27 can also claim for slightly higher exempted amounts depending upon their age in order to provide for their own support and education (§ 17 ErbStG). There are also provisions for certain types of assets belonging to the household of the deceased or certain types of artwork (§ 14 ErbStG).

If these exemption amounts are exceeded the following tax rates apply (§ 19 ErbStG):

%-Tax Rate per Class

Inheritance

I

II

III

75 000

7

15

30

300 000

11

20

30

600 000

15

25

30

6 000 000

19

30

30

13 000 000

23

35

50

26 000 000

27

40

50

over 26 000 000

30

43

50

The DTT with the US

If in the case of unrestricted tax liability a treaty, such as that with the U.S., exempts a part of the inheritance from being taxed in Germany then the tax is calculated as though no part of the inheritance were exempted (§ 19 Para. 2 ErbStG).

The most noteworthy aspect of this treaty might very well be that it only governs conflicts between U.S. federal estate and gift tax including the generation skipping tax and German inheritance tax (Art. 2 of the Treaty). It does not apply in respect to local estate and inheritance taxes, which many U.S. states still collect, while none of the German states do. As the amount exempted under the U.S. federal tax is still very high, (a little bit more than USD 5 million in 2014), and because state law exemptions are much lower (for example about USD 2 million for NY in 2014), this means that this treaty does not affect as many real world cases as one might think. Statistically, the set-off-procedure established by Art. 21. ErbStG which regulates the conflict between German federal inheritance tax and the tax systems of the individual U.S. states might be much more important than the Treaty. The argument against this is that those U.S. states in which estates are most likely to have a link with Germany, namely Florida and California, do not collect an individual estate tax at all. Thus, in respect to estates situated there, potential taxation conflicts can only arise under the Treaty and be resolved by it. However, in respect to states that still have an estate and/or inheritance tax, § 21 ErbSt certainly deserves a look

When can estate and gift taxes paid abroad be set off against German inheritance tax (§ 21 ErbStG)? Doubts about a recent court decision (Federal Fiscal Court (BFH) Judgment of June 19th. 2013, II R 10/12).

To summarize the relevant parts of the Act, § 21 ErbStG provides that in the case of unrestricted German inheritance tax liability, which is to say if either the transferor or the transferee were German residents within a five-year time frame prior to the transfer, the foreign tax can be set off against German inheritance and gift tax to the extent that foreign assets are also subject to it. In the case of restricted German inheritance tax, however, which is to say neither the transferor nor the transferee had any other link to Germany than a few assets being situated here, the outcome is the same, since the statute provides that even German assets can be deemed to be foreign assets for the purpose of this set-off procedure (§ 21 Para 2 No.2 ErbStG).

Amazingly, the real issue in respect to this procedure that sometimes German fiscal courts are called upon to decide upon is which foreign taxes for which either a death or a gift is the initial triggering requirement are in fact inheritance or estate/gift taxes, and which are more similar to an income tax, that cannot be set off against German inheritance tax. The general tendency of the courts is to become more and more restrictive on this issue. In the first decision it was decided that Canadian capital gains taxes due on death are not deemed to be estate or inheritance taxes that could be set off, but it was still permitted for them to be taken into account as a liability of the estate, so that at least the tax burden was diminished by them (BFG Judgment of April 26th. 1995, Record Number, II R 13/92). Following this, comparability was affirmed for an Italian capital gains tax due on death (Fiscal Court of Munich, Judgment of November 14th, 2001, Record Number 4 K 2407/98) but rejected by the German fiscal authority for a Portuguese inheritance-surrogate-tax (H 82 ErstR 2003).

The most recent decision on ultimately the same issue, albeit discussed in a different legal context, is from summer 2013 (BFH, Judgment of June 19th 2013, Record number: II R 10/12). In this, the highest German fiscal court decided that French estate taxes could not be set off against German inheritance taxes because in the case of unrestricted tax liability, the deceased was a German citizen and resident, and a bank account in France as a claim against the bank is no longer deemed to be a “foreign asset” from the German perspective unless it were secured by some real property interest - against the bank (!). To put it very politely, this result is at least questionable,in particular because on the face of it, neither the financial crisis nor the amazing acceleration in European unification can be said to underlie it. This decision means that in the absence of a treaty, foreign estate taxes can no longer be set off against German inheritance taxes if bank accounts in foreign countries and shares in foreign corporations are concerned, because they are not foreign assets from a German perspective, at least if the transferor or the transferee are German residents at the time of the transfer. To polemicize a little, this clearly violates any plain-meaning rule and maybe even the sovereignty of the French state; though the court does in fact write a great deal about E.U. laws allegedly supporting this position.

For the U.S. however, there is still the Treaty and a very old decision (BFH Decree of March 6th 1990, Record Number: II R 32/86) affirming the comparability of federal estate tax and German inheritance tax even for cases that are not regulated by the governing treaty. Though a decision addressing these issues in respect to inheritance and estate taxes under state law, it might be assumed that these are still deemed to be comparable so that the taxes can be set off against each other as long no U.S. state legislator starts to frame its inheritance/estate tax in such a way that it rather comes to resemble the last income tax return of the deceased or the giftor.

If you have any further questions about probate, estate, trust and tax matters in Germany or the EU, please do not hesitate to contact the author by an email to: info@jahn-law.com.

Just a quick amendement: In the meantime the federal constutional court has struck down large parts of the inheritance and gift tax law described above. However, these parts all deal with the life-time or post mortem transfer of entrepreneurial entities. Besides, the court has given the legislator time until the middle of 2016 to reform the statute. So, it does really Impact the summary given above.

Two additional points:1.) In the meantime the German legislator has reacted and adopted a new statute in fall 2016.2.) More important for None-Residents:There are two decisions by the European Ct. of Justice voiding the original section dealing with lower exemption amounts for None-Germans described above as well as a later legislative remedy for it under the EU''''s equal protection clause (EuCtJ. "Huennebeck" judgment from June 8th 2016, CS 459/14 and Mattner judgment from April 22nd 2010).